Safe Harbors / Qualified Intermediaries


In May of 1991, the Department of Treasury published regulations on deferred exchanges (TD 8346 containing Reg. 's 1.1031(b)-2 and 1.1031(k)). These regulations set out complex rules for identifying and receiving replacement property. They also addressed various issues in regard to multiple asset exchanges; incidental property transfers made as part of an exchange, and revocation of replacement property identifications. However, the most significant provisions included in these Regulations dealt with the establishment of 3 safe harbors. These safe harbors provided taxpayers with a vehicle to avoid receipt or constructive receipt of sales proceeds while securing the taxpayers' funds and the obligation of the transferee to acquire replacement property.

Safe Harbors - Reg. 1.1031(k)-1(g) established the following 3 safe harbor arrangements:

  • Security or guarantee arrangements.
  • Qualified escrow or trust arrangements.
  • Qualified Intermediary (QI) arrangements.

Of the three, the use of a Qualified Intermediary provides the greatest flexibility in dealing with recurring multiple exchanges of like kind personal property.

The Qualified Intermediary Safe Harbor

Under this safe harbor, the QI functions as the cash middle man between the taxpayer and the buyer of relinquished property and the taxpayer and the seller of replacement property. The workings of a Deferred Exchange under the QI safe harbor can best be illustrated by the following flowchart:

Exchanges of property qualify for tax deferral only to the extent that property is exchanged solely for property of a like kind. Regulations expressly limit the taxpayer's rights to receive, pledge, borrow, or otherwise obtain the benefits of any sales proceeds whether those sales proceeds are paid in the form of cash, other non-Like-Kind property or buyer notes. In those situations where the buyer's consideration is paid in a form other than like-kind replacement property, sales proceeds are generally remitted directly to the QI who then uses the value of this non-like-kind property to acquire replacement property and otherwise accomplish the taxpayer's exchange.

This is not to say that title to property must also flow through the QI. On the contrary, title to relinquished property may flow directly from the taxpayer to the buyer and title for replacement property may flow directly from the seller to the taxpayer. Regulations only require that the taxpayer enter into a written exchange agreement with the QI (the "Exchange Agreement") whereby the taxpayer agrees to assign its interest in the purchase and sales contracts to the QI and give notice of this assignment to all parties involved.

Once sales proceeds are deposited with the QI, they can only be used to retire outstanding debt on the property sold; pay transaction and exchange related costs or acquire replacement property. Accordingly, any non-like-kind property received by the QI (net of relinquished property debt and exchange fees and expenses) must either be reinvested in like kind replacement property or they must remain under the QI's control for the duration of the related 45 day / 180 day exchange period.

 
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